We, at The Share Centre, are of the view global expansion in the near-term looks sustainable, as economic growth across regions seem inlock-step albeit at subdued pace, credit markets are behaving, and volatility remains muted. Central bank’s monetary policies in the main are likely to remain accommodative with the exception of the US.
This doesn’t mean however, that stumbling blocks don’t remain which could ultimately increase volatility as we head through 2018. Indeed, investors have the ongoing Brexit negotiations to deal with, which could put further strains on the confidence in the UK government. US inflation could get ahead of itself over the course of the year, as the tax reform package kicks in, giving a boost to corporate earnings, reducing the consumer tax bill and running a higher fiscal deficit is highly reflationary. This has the potential to lead the FED to raising rates more aggressively than the market expects. In Europe headlines will likely be dominated by continued challenges to the status of the European Union from Brexit, elections in Italy to tension over Catalonia. While the threat from a rise in populism, protectionism and the ongoing threat of terrorism will not be far from sight.
We are not anticipating any major economy falling into recession in 2018, suspecting the boost from US tax reform package to ripple out across markets potentially extending stretched valuations before fading out as the sun sets on the year. Leading us to believe that investment returns early in 2018 will be tempered by FED rate hikes leaving investors with only moderate returns by year end. Despite noting stretched valuations in some parts of the equities market remains our preferred asset class believing the cycle has not yet reached the ‘Euphoria’ phase in the cycle. This is despite having reservations over valuations and levels of leverage in some parts of the market.
United in name, but perhaps not in nature
Due mainly to Brexit we expect, like the Governor of the Bank of England, the UK market will continue to participate a little less in the global up swing. Whilst we have some doubt about a sustainable trend in UK rates rising, a rise none the less will hopefully lead to better capital allocation ahead.
The global picture
Falling unemployment, improving policy reforms and reduced budget deficits across Europe are providing a positive backdrop for growth. With evidence that inflation is picking up in the continent, combined with the likelihood that the European Central Bank (ECB) won’t raise rates until 2019 and the recovery in the region becoming more self-sustaining, we expect valuation to continue to rise in 2018. ‘Some uncertainties do remain though as a result of ongoing social and political challenges. We could for example see Germany going back to the ballot box, Italian elections could see the rise to power of the Five Star movement and it can’t be ruled out that the Catalan situation in Spain could be revisited.
Across the pond, the Dow Jones continued to set new highs in 2017 as a result of foreign investors buying US stocks at the fastest rate since 2012. Going into 2018 investors will likely be beneficiaries of tax reforms and certainly in early 2018 markets could ride this wave to newer highs in the market.
Whilst the picture for the US looks encouraging, the market could be tempered by the yield curve continuing to flatten and it is possible that if inflation rises faster than the market is currently anticipating, then the FED could impose more rate hikes in 2018 than the market is currently anticipating. Wage growth may also start biting into corporate earnings.
The re-election of Shinzo Abe in Japan in late 2017 should provide investors with some reassurance Abenomics will continue ahead. Inflation is likely to remain low, with the possibility of deflation returning keeping monetary policy remaining ultra-loose for the foreseeable future. The desire to maintain loose monetary policy is likely to lead to another dovish Bank of Japan governor succeeding Kuroda. We are encouraged and remain positive on the outlook for earnings growth, helped by improving corporate governance and the government targeting corporates to deliver Return on Equity (RoE), above 8 per cent.
The Emerging Markets
Growth in China appears to be stabilising and its economy appears to be avoiding a hard landing. Policy is likely to continue to moderate highlighted by the recent National Congress of the Communist Party of China conference. China is the big risk in emerging economies given its high corporate debt and weak banks, which is likely to weigh on growth. Yet China should be in a position to bail banks out if it became necessary.
Brazil’s recovery was initially led by agriculture and it has been expanding and becoming broader based. A boost to domestic consumption is likely to further strengthen the recovery helped by falling unemployment, wage growth and lower interest rates. As well as this, Brazil is becoming less sensitive to the US Dollar as its current account deficit continues to shrink, diminishing one of the major external threats to the economy. However, headwinds still exist. Crucial to improving its economic outlook is scope to implement measures that will stabilise the country’s fiscal position and further boost business confidence. Without reforms being passed there is a real chance Brazil could sink back into recession.
Progress is being made in India with the pro-business reform agenda. This was recently acknowledged by the ratings agency Moody as a result of it upgrading the country’s local and foreign currency sovereign ratings to Baa2 up from Baa3 and elevating its outlook to ‘stable’. With the roll out of the Goods and Services Tax (GST), anti-corruption measures, GDP growth recovering which should contribute to declining government debt, a pickup in corporate earnings, and it moving up into the top 100 regions worldwide for ease of doing business, the outlook remains encouraging.
At The Share Centre, we are expecting returns from equities to moderate in 2018 but still we maintain a preference for equity investing over fixed income in 2018 while many economies are demonstrating positive rates of growth.
Growth rates in many economies are being supported by falling unemployment in some regions and are at lows in others, economic slack tightening, and tighter monetary policy and in some cases rates are being hiked.
As highlighted we have regional bias for European, Japanese and Indian equities relative to the US. However, we believe investors should not be too light in their US exposure, as we continue to see opportunities in Technology, Healthcare and Financials all sectors of the market that America has dominance in.
Sheridan Admans, investment manager at The Share Centre.
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